The key to successful investing and golfing is to determine when risk is necessary to accomplish your goals and when it is not. As I watch the phenomenal professional golfers tend to their craft this summer, I thought of the similarities that risk has in both pursuits.
Watching the different styles of the golfers at last month’s British Open reminds me of an analogy that I sometimes use while talking to prospects. For while each of the golfers is trying to complete the four rounds of golf in the least amount of strokes, the way they attack and plan to accomplish this varies. This is also true for investors.
All investors should be trying to accomplish a certain goal specific to their needs and wants. However, just as players use different styles to accomplish their goals, so do investors with their style and tolerance for portfolio risk. Investors should be aware of the trade-off between the risks in their portfolios and the expected returns from those portfolios.
Matching the correct portfolio to both the needs and wants of the client, as well as the client’s ability to withstand the risk taken, is a paramount issue for financial advisors.
Let’s give an example: a par 5 hole on a golf course requires that the golfer put the ball from the tee shot into the hole on the fifth shot to be on par. Golf course designers, especially on the more challenging courses, routinely design the course to have a risk return trade-off throughout the course. The course design was developed so that the player may have the opportunity to go over the lake to reach the green in two shots.
If the player was successful with this risky shot, they could be rewarded with sinking the putt in two strokes – resulting in a positive result – a one under score of 4 known as a birdie. However, if this risky shot did not reach the green and ended up instead in the water, then what was a potential benefit could result in a negative score of 6 or more – known as a bogey.
Investors encounter these risk return trade-offs as well. There are asset classes that have been shown to deliver higher returns. However, these asset classes do come with added risk dimensions – most notably short-term volatility or stock movements up and down, more than the market in general. A few of these asset classes are small company stocks, value company stocks and companies in the emerging markets.
This follows the famous slogan of Wall Street: “there is no free lunch”. If you want a high investment return or, more importantly, need a higher investment return to reach your goals, then your portfolio needs to include the higher performing (and higher risk) asset classes such as stocks.
The key to successful investing and golfing is to determine when risk is necessary to accomplish your goals and when it is not. Phil Mickelson is notorious on the golf course for taking risks when it does not seem appropriate. Try not to follow his lead when you’re investing for your goals. Sit down with a financial coach to determine the risks that you need to face and how a well-diversified portfolio – held through time – can help accomplish these life goals.
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